The minimum wage and Earned Income Tax Credit: Partners in making work pay

The minimum wage and Earned Income Tax Credit: Partners in making work pay

The Earned Income Tax Credit (EITC), one of the most substantial and popular federal anti-poverty programs, is an important piece of the ongoing strategy to make work pay, but its effectiveness in raising the incomes of the working poor above the poverty line depends in part on regular increases in the minimum wage.

One reason for the EITC’s popularity is that it is based on family income and is therefore well targeted to poor families. In addition, EITC encourages work because the wage subsidy increases with earnings until it reaches the maximum ($4,204 for a family with two children in 2002). The amount of the maximum credit is adjusted for inflation each year.

Consider a single mother of two children working 40 hours per week year-round at the minimum wage of $5.15. In 1997, this worker would have earned $9,893 after Social Security and Medicare taxes—only 77% of the poverty line. But, as shown in the figure below, because this worker would have been eligible for the maximum EITC of $3,656, her family income would have surpassed the poverty threshold (which is adjusted annually for inflation).

The poverty threshold rises each year to reflect the rising cost of living. The federal minimum wage, however, does not. As a result, a single mother with two kids working the same number of hours each year at the minimum wage would be further away from the poverty line each year the minimum wage is not increased. By 2003, her earnings would equal 67% of the poverty line and the EITC would no longer push her income above the poverty line (as illustrated by the second bar in the figure). To make matters worse, as the purchasing power of the minimum wage falls each year that the minimum wage does not rise with inflation, the amount of EITC for which this family is eligible will also start to fall. 1

The proposal to raise the federal minimum wage to $7.00 fixes this problem. The higher minimum wage and the Earned Income Tax Credit work in tandem to raise the income of the family described above to 16% more than the poverty line. While this family would certainly have a difficult time making ends meet at that income level (less than $18,000 per year), the addition of more than $3,000 of net income would be a significant improvement. A proposal that sets annual increases to the federal minimum wage to adjust for changes in the cost of living would ensure that the combination of the full-time work and the EITC would always keep this family above the poverty line.

1. The EITC is designed so that the amount of the credit rises as earnings from work rise. The level of earnings at which the family is eligible for the maximum EITC is adjusted annually for inflation. Beginning in 2005, a single mother with two children working full time at the minimum wage would no longer be eligible for the maximum credit. An increase in the minimum wage to $7.00, along with automatic annual increases, would solve this problem.

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